As many of my regular readers know, I’ve already written a few articles on Bitcoin that explain why it is money. In those articles I have addressed why the inherent properties of Bitcoin give it value as a medium of exchange. One of those properties that I mentioned, but did not go into very deeply, is the deflationary aspect of the currency system.

Bitcoins are inherently deflationary as a currency because they will eventually top out in the number that can be produced. Eventually total Bitcoin circulation will reach about 21 million coins, and after that, no new coins can be created. Thus, if no new money can be created, yet if the productive capacity of the economy increases, prices will fall since there will be more goods chasing the same amount of coins.

Most people remember hearing that deflation is just as bad (or worse) than inflation from their high school or college economics teachers. In this article I will explain why those assumptions are wrong. Deflation is when a currency gains value over time (i.e. you need less and less of it to buy the same amount of goods in the future).

So let’s list off the reasons why crackpot Keynesian economists think deflation is bad for the economy. Then I will address each of those points. You are about to see a guy with a BBA in MIS smash a Noble prize winning PhD economist’s arguments using simple common sense.

There are actually three different reasons to worry about deflation, two on the demand side and one on the supply side.

So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow…even a zero rate may not be low enough to achieve full employment.

A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts.

Finally, in a deflationary economy, wages as well as prices often have to fall – and it’s a fact of life that it’s very hard to cut nominal wages — there’s downward nominal wage rigidity.

Those arguments against deflation are typical Keynesian dogma. In fact I actually wrote out the exact same three arguments before I even read Krugman’s article, but I figured it would be better if I listed them off right from the horse’s mouth.

So let’s address the first argument that people become less willing to spend, and particularly less willing to borrow, and this somehow leads to unemployment. There will ALWAYS be some unemployment if the economy is not in equilibrium (which it never is, since human desires change over time). As people shift their desires from wanting notebook computers to iPads, some unemployment will result from this. Consider that if the demand for notebooks drops while the demand for iPads increases, notebook producers will end up having to lay people off or go out of business while iPad producers will be hiring more people. The people in transition are going to be unemployed while they look for new work.

But setting that point aside, we have to look at why money undergoes deflation in the first place! It is not surprising that Krugman doesn’t mention the reasons why deflation occurs in a currency. There are basically only two reasons (on a macro scale) why a currency would undergo deflation:

1. The economy is producing more new goods and services at a rate that is above the growth rate of the money supply…. or

2. In a fractional reserve system, debt is being wiped out through widespread bankruptcies.

Consider that in the first case, this is entirely normal and healthy! If the money supply is held constant, yet the productive capacity of the economy increases, there will be the same number of dollars chasing more goods. Inflation is the exact opposite of this, whereby same dollars are chasing fewer goods (or more dollars chasing same/less goods). Clearly deflation in this sense is beneficial for consumers. We see this taking place in the electronics industry which is largely free from government regulation and subsidies. When competition is fierce, the productive capacity of industry over-rides the inflationary aspects of our fractional reserve economy and we see prices come down as more and more electronic goods are produced more efficiently.

Imagine if the electronics industry operated like the government subsidized and regulated healthcare industry. You would buy all the electronics you could now, because in the future, they would be so expensive you might not be able to afford them! So yeah, in this sense, inflation encourages spending. But clearly this is UNHEALTHY spending caused by people fearing the loss of their purchasing power.

Inflation creates a fear based economy that motivates people to spend above their means because the future value of their purchasing power is constantly decreasing. It would be foolish to try and save money for future expenditures in an inflationary economy, which obviously destroys savings. People who save for their retirement by putting money in a bank would be fools in an inflationary environment.

In fact if the inflation gets bad enough and interest rates are artificially low, people would be motivated to take out excessive loans and credit card debt to try and get as many things as they could now! Boy that sure sounds like a problem we are all familiar with doesn’t it?

Krugman’s argument that people would be less willing to spend and borrow, and this would lead to unemployment, is as ridiculous as saying that because computers keep getting better and cheaper into the future, people would be less willing to spend money on a computer today because they could simply wait and buy an even better/cheaper computer in the future. That is obviously not how people think. People have needs and desires that have to be met, and they will purchase things as soon as their desire for the product is larger than their desire for future earnings on savings. That, by the way, is how a healthy economy should operate. Notice there is no fear involved. Electronics companies are not going out of business because their products are becoming more abundant and cheaper.

So let us look at Krugman’s second argument that deflation makes debtors worse off. What is left unsaid in this assumption is that debt is a good thing, while saving is a bad thing. Does this make any logical sense to anyone? Consider that if money is undergoing deflation, SAVERS benefit. Shouldn’t the savers naturally benefit more than someone who is putting themselves into debt? Savers are forgoing pleasure in the moment for the expectation of even greater pleasure in the future. This means resources that could be consumed immediately for minimal productive gains are being put aside into bigger projects that could yield even greater gains in the future. Savings is what builds strong economic foundations. If the US wasn’t so wildly in debt at the moment we would be in a better economic position with larger prospects for growth!

But also let us consider the impacts of deflation on interest rates. People who lend and borrow money will know that money will be worth more in the future if the money supply remains constant (like Bitcoins) yet the productive capacity of the economy continues to increase. This leads to falling interest rates. Interest rates will naturally come down in a deflationary environment because savings will increase, thereby making more money available to banks to lend. When banks have a lot of people saving money with them, they will lower rates naturally. This is in contrast to our present situation where rates are low strictly because the Fed is artificially depressing them by paying banks NOT to lend and by buying up government bonds.

Distortion of interest rates by the Fed also has other deleterious effects on the structure of production that I will not get into here, but according to Austrian Business Cycle Theory, inflation and its distortion of interest rates is the primary driver of business cycles. Learn more about it by watching this video by Professor Roger Garrison.

Which situation sounds healthier to you? Low interest rates because a lot of people are saving money or low interest rates because the Fed is artificially depressing them with tax payer money?

So let us address Krugman’s final argument that wages face downward rigidity which makes it more difficult for employers to adjust to the money that is gaining in value.

Consider if you were in this situation:

Your employer gathers up all the employees for a conference and tells you that because the economy is so productive and that the value of money is going up so much, that he is going to have to furlough the workforce to deal with the appreciating currency.

From your perspective, you are getting more time off while your income remains exactly the same in terms of purchasing power. Who doesn’t want that? Further, consider that if you don’t get a raise every year, YOU STILL GET A RAISE! Employers don’t necessarily have to cut wages; they can cut hours or simply not give raises yet people would still be better off than they were the year before.

But let’s say the economy is so productive that money gains so much value that employers are simply forced to cut wages – if this was the case, would anyone seriously give a damn? We would be living in a nirvana society that had absolutely ridiculous amounts of abundance. Women could stay home to take care of the kids, one man could provide all the income necessary to take care of his family and still retire, kids wouldn’t have to work three jobs to put themselves through school, etc… etc… etc…

Less people would need to work in such an economy (like they did in the 50s and 60s) which would relieve the need of employers to cut wages.

Oh yes, one more thing. I suppose I should address the second cause of deflation other than increasing productivity while the money supply remains constant – and that is a deflationary default spiral that results from the unwinding of a Ponzi scheme. This is the real reason why Keynesian economists fear monger about deflation. Since in our crazy society, money IS debt, if debtors get themselves into a position where they are so over-leveraged that they are forced into bankruptcy, it can cause a cascading series of defaults that wipe out the banking industry (along with the government and its welfare/warfare state). As debt gets wiped out, the money supply decreases which leads to deflation.

Keynesian economists have to continually fear monger about deflation because even a tiny amount of it could wipe out our Ponzi debt based economy, and thereby wipe out their fat government aid fueled paychecks. To learn more about the scam that is our debt based economy, check out The Case Against The Fed. It offers a clear picture of how the modern banking system operates and why it was created. If you are looking for something slightly more entertaining, yet still informative, check out The American Dream. It is gives a great overview of what fractional reserve banking is and why it is nothing more than a Ponzi scheme.

Keynesian economists like Krugman don’t have your best interests in mind when they argue against deflation. They are far more concerned about keeping the welfare/warfare state alive and well, along with their own paychecks.

There are actually three different reasons to worry about deflation, two on the demand side and one on the supply side.

So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow…even a zero rate may not be low enough to achieve full employment.

A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts.

Finally, in a deflationary economy, wages as well as prices often have to fall – and it’s a fact of life that it’s very hard to cut nominal wages — there’s downward nominal wage rigidity.

Those arguments against deflation are typical Keynesian dogma. In fact I actually wrote out the exact same three arguments before I even read Krugman’s article, but I figured it would be better if I listed them off right from the horse’s mouth.

So let’s address the first argument that people become less willing to spend, and particularly less willing to borrow, and this somehow leads to unemployment. There will ALWAYS be some unemployment if the economy is not in equilibrium (which it never is, since human desires change over time). As people shift their desires from wanting notebook computers to iPads, some unemployment will result from this. Consider that if the demand for notebooks drops while the demand for iPads increases, notebook producers will end up having to lay people off or go out of business while iPad producers will be hiring more people. The people in transition are going to be unemployed while they look for new work.

But setting that point aside, we have to look at why money undergoes deflation in the first place! It is not surprising that Krugman doesn’t mention the reasons why deflation occurs in a currency. There are basically only two reasons (on a macro scale) why a currency would undergo deflation:

1. The economy is producing more new goods and services at a rate that is above the growth rate of the money supply…. or

2. In a fractional reserve system, debt is being wiped out through widespread bankruptcies.

Consider that in the first case, this is entirely normal and healthy! If the money supply is held constant, yet the productive capacity of the economy increases, there will be the same number of dollars chasing more goods. Inflation is the exact opposite of this, whereby same dollars are chasing fewer goods (or more dollars chasing same/less goods). Clearly deflation in this sense is beneficial for consumers. We see this taking place in the electronics industry which is largely free from government regulation and subsidies. When competition is fierce, the productive capacity of industry over-rides the inflationary aspects of our fractional reserve economy and we see prices come down as more and more electronic goods are produced more efficiently.

Imagine if the electronics industry operated like the government subsidized and regulated healthcare industry. You would buy all the electronics you could now, because in the future, they would be so expensive you might not be able to afford them! So yeah, in this sense, inflation encourages spending. But clearly this is UNHEALTHY spending caused by people fearing the loss of their purchasing power.

Inflation creates a fear based economy that motivates people to spend above their means because the future value of their purchasing power is constantly decreasing. It would be foolish to try and save money for future expenditures in an inflationary economy, which obviously destroys savings. People who save for their retirement by putting money in a bank would be fools in an inflationary environment.

In fact if the inflation gets bad enough and interest rates are artificially low, people would be motivated to take out excessive loans and credit card debt to try and get as many things as they could now! Boy that sure sounds like a problem we are all familiar with doesn’t it?

Krugman’s argument that people would be less willing to spend and borrow, and this would lead to unemployment, is as ridiculous as saying that because computers keep getting better and cheaper into the future, people would be less willing to spend money on a computer today because they could simply wait and buy an even better/cheaper computer in the future. That is obviously not how people think. People have needs and desires that have to be met, and they will purchase things as soon as their desire for the product is larger than their desire for future earnings on savings. That, by the way, is how a healthy economy should operate. Notice there is no fear involved. Electronics companies are not going out of business because their products are becoming more abundant and cheaper.

So you are essentially agreeing with Krugman on spending and borrowing, and vacuously agreeing with him on employment.

Quote

So let us look at Krugman’s second argument that deflation makes debtors worse off. What is left unsaid in this assumption is that debt is a good thing, while saving is a bad thing. Does this make any logical sense to anyone? Consider that if money is undergoing deflation, SAVERS benefit. Shouldn’t the savers naturally benefit more than someone who is putting themselves into debt? Savers are forgoing pleasure in the moment for the expectation of even greater pleasure in the future. This means resources that could be consumed immediately for minimal productive gains are being put aside into bigger projects that could yield even greater gains in the future. Savings is what builds strong economic foundations. If the US wasn’t so wildly in debt at the moment we would be in a better economic position with larger prospects for growth!

But also let us consider the impacts of deflation on interest rates. People who lend and borrow money will know that money will be worth more in the future if the money supply remains constant (like Bitcoins) yet the productive capacity of the economy continues to increase. This leads to falling interest rates. Interest rates will naturally come down in a deflationary environment because savings will increase, thereby making more money available to banks to lend. When banks have a lot of people saving money with them, they will lower rates naturally. This is in contrast to our present situation where rates are low strictly because the Fed is artificially depressing them by paying banks NOT to lend and by buying up government bonds.

Distortion of interest rates by the Fed also has other deleterious effects on the structure of production that I will not get into here, but according to Austrian Business Cycle Theory, inflation and its distortion of interest rates is the primary driver of business cycles. Learn more about it by watching this video by Professor Roger Garrison.

Which situation sounds healthier to you? Low interest rates because a lot of people are saving money or low interest rates because the Fed is artificially depressing them with tax payer money?

You are not arguing against Krugman's point here. Fair enough, as common sense will show his point is true.

Quote

So let us address Krugman’s final argument that wages face downward rigidity which makes it more difficult for employers to adjust to the money that is gaining in value.

Consider if you were in this situation:

Your employer gathers up all the employees for a conference and tells you that because the economy is so productive and that the value of money is going up so much, that he is going to have to furlough the workforce to deal with the appreciating currency.

From your perspective, you are getting more time off while your income remains exactly the same in terms of purchasing power. Who doesn’t want that? Further, consider that if you don’t get a raise every year, YOU STILL GET A RAISE! Employers don’t necessarily have to cut wages; they can cut hours or simply not give raises yet people would still be better off than they were the year before.

How would cutting hours work? Assuming the business is being run with reasonable efficiency, cutting hours worked will decrease the amount of product produced, decreasing income, and causing the business to shrink.

Quote

But let’s say the economy is so productive that money gains so much value that employers are simply forced to cut wages – if this was the case, would anyone seriously give a damn? We would be living in a nirvana society that had absolutely ridiculous amounts of abundance. Women could stay home to take care of the kids, one man could provide all the income necessary to take care of his family and still retire, kids wouldn’t have to work three jobs to put themselves through school, etc… etc… etc…

Less people would need to work in such an economy (like they did in the 50s and 60s) which would relieve the need of employers to cut wages.

Oh yes, one more thing. I suppose I should address the second cause of deflation other than increasing productivity while the money supply remains constant – and that is a deflationary default spiral that results from the unwinding of a Ponzi scheme. This is the real reason why Keynesian economists fear monger about deflation. Since in our crazy society, money IS debt, if debtors get themselves into a position where they are so over-leveraged that they are forced into bankruptcy, it can cause a cascading series of defaults that wipe out the banking industry (along with the government and its welfare/warfare state). As debt gets wiped out, the money supply decreases which leads to deflation.

Keynesian economists have to continually fear monger about deflation because even a tiny amount of it could wipe out our Ponzi debt based economy, and thereby wipe out their fat government aid fueled paychecks. To learn more about the scam that is our debt based economy, check out The Case Against The Fed. It offers a clear picture of how the modern banking system operates and why it was created. If you are looking for something slightly more entertaining, yet still informative, check out The American Dream. It is gives a great overview of what fractional reserve banking is and why it is nothing more than a Ponzi scheme.

So people will be smarter in a society with deflationary currency? This is the only point of Krugman's three that are not so obviously true.

Quote

Keynesian economists like Krugman don’t have your best interests in mind when they argue against deflation. They are far more concerned about keeping the welfare/warfare state alive and well, along with their own paychecks.

I'm not agreeing with Krugman on anything because at the beginning of his article he says:

Quote

A number of readers have asked me to explain why deflation is a bad thing;

There are actually three different reasons to worry about deflation

Whereby I am demonstrating that inflation is GOOD - not bad.

Debtors are helped by deflation because it lowers interest rates, so even his premise is wrong on that one. On the others he's simply taking the position of the debtor, which means he is advocating that people should be in debt while at the same time completely ignoring the economic benefits of saving.

It's like he doesn't even acknowledge that debt causes problems or creates economic bubbles.

The arguments about debt are largely nonsense, in both directions. As long as the rate of inflation/deflation doesn't change abruptly, that rate is figured into the loan at inception, or the loan can contain provisions for adjustments.

And if workers have a hard time adjusting to falling wages in a deflationary world, they are defective in the brain. They will quickly come around as they realize that the alternative is for their wages to fall to zero abruptly as their employers replace them with non-defective workers.

The arguments about debt are largely nonsense, in both directions. As long as the rate of inflation/deflation doesn't change abruptly, that rate is figured into the loan at inception, or the loan can contain provisions for adjustments.

And if workers have a hard time adjusting to falling wages in a deflationary world, they are defective in the brain. They will quickly come around as they realize that the alternative is for their wages to fall to zero abruptly as their employers replace them with non-defective workers.

I'm not sure what you mean about "in both directions."

It should be evident from the article that debt levels and interest rates will adjust themselves to optimal levels when the market is free to set rates and inflation is absent (which acts as an interest rate distorter).

Pumping artificial money into an economy artificially lower rates, which distorts the structure of production leading to booms/busts and debt bubbles. The less a money is inflated, the less interest rate distortion that can be expected to occur. The ideal situation is to have no inflation of the money supply at all.

The arguments about debt are largely nonsense, in both directions. As long as the rate of inflation/deflation doesn't change abruptly, that rate is figured into the loan at inception, or the loan can contain provisions for adjustments.

And if workers have a hard time adjusting to falling wages in a deflationary world, they are defective in the brain. They will quickly come around as they realize that the alternative is for their wages to fall to zero abruptly as their employers replace them with non-defective workers.

I'm not sure what you mean about "in both directions."

It should be evident from the article that debt levels and interest rates will adjust themselves to optimal levels when the market is free to set rates and inflation is absent (which acts as an interest rate distorter).

Pumping artificial money into an economy artificially lower rates, which distorts the structure of production leading to booms/busts and debt bubbles. The less a money is inflated, the less interest rate distortion that can be expected to occur. The ideal situation is to have no inflation of the money supply at all.

Deflation is bad for borrowers, inflation is bad for lenders. What is bad for either of them is bad for lending as a practice. So I'm just saying that an argument in favor of either one has a reciprocal argument that leads to the same conclusion. Even worse, as long as whatever you have is reasonably predictable, the effects can be mitigated. Any argument in the inflation/deflation debate that involves debt is therefor pointless to make or consider.

The distortion from having banks create money, and thus create inflation, is a secondary effect. Markets have some lag, so any particular place that inflation or deflation hits first will be distorted in relation to the rest of the economy. Invoking this argument is really an argument for or against some particular scheme of inflation distribution with regards to time, and not an argument in the inflation/deflation debate itself. Unless it can be shown, and so far I don't think anyone has, that there is a distortion natural to all systems of inflation or deflation.

We probably agree philosophically, but I don't think these particular arguments are very strong.

For what it is worth, I prefer the bitcoin model with a fixed total money supply and no way to ever increase it. I don't care so much about inflation or deflation, so long as it is the market making the decision, and not some guy or group.

In an inflation based monetary system, its very difficult to do long term projects. As soon as a budget is put together and a plan is made, the distortions of inflation makes the project fail.

Why do you think that all the large scale building projects in the US all really happen prior to 1970? There are no more massive interstate, train, dams, etc because any project going over say 3 years will be doomed to failure (ie. see "Big Dig" in boston which was supposed to cost $2B is now estimated the final bill will be $22B).

Whereas with a deflationary currency, the project gets 'cheaper' as it moves along. Meaning that the original budgets (if done correctly) are usually sufficient to carry through the term of the project.

Once you understand this, you will begin to notice it all around you. Drive around in your car for bit....all new buildings are constructed of stucco and sheetrock, and thrown together in 3 months. Compare and contrast that with the old bank in the center of town....built in the 1920's of stone and marble. One will be here for another 100 years, the other one will be torn down in 10.

In an inflation based monetary system, its very difficult to do long term projects. As soon as a budget is put together and a plan is made, the distortions of inflation makes the project fail.

Why do you think that all the large scale building projects in the US all really happen prior to 1970? There are no more massive interstate, train, dams, etc because any project going over say 3 years will be doomed to failure (ie. see "Big Dig" in boston which was supposed to cost $2B is now estimated the final bill will be $22B).

I lol'd.

Big building projects are FINANCED, that means borrowed money. So the exact opposite of what you're saying is true. It's deflation that hurts the business paying back the loan for the large projects. Inflation helps the borrowing business. As someone already pointed out, inflation/deflation arguments based on a debt are a wash.

The discussion of savers is also flawed. Deflation leads to hording money. Savers save by defintion, they don't spend their savings at a later date. All that money being saved (horded) is money not being circulated in the economy.

Stuff like this:

Quote

But let’s say the economy is so productive that money gains so much value that employers are simply forced to cut wages – if this was the case, would anyone seriously give a damn? We would be living in a nirvana society that had absolutely ridiculous amounts of abundance. Women could stay home to take care of the kids, one man could provide all the income necessary to take care of his family and still retire, kids wouldn’t have to work three jobs to put themselves through school, etc… etc… etc…

Less people would need to work in such an economy (like they did in the 50s and 60s) which would relieve the need of employers to cut wages.

is just straight up laughable. That's the same kind of childish logic that says "zomg guize, inflation is great because everyone has more money!!!" You're simply saying, "zomg guys, deflation is great because money is worth so much more!!!"... while completely overlooking the fact that there is now a hell of a lot less money around, interest rates for essential items like home and car loans are through the roof, unemployment is rampant, etc.

I give you an F for effort and gross, biased oversimplification/failure to understand how vast the number of forces at work are.

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Big building projects are FINANCED, that means borrowed money. So the exact opposite of what you're saying is true. It's deflation that hurts the business paying back the loan for the large projects. Inflation helps the borrowing business. As someone already pointed out, inflation/deflation arguments based on a debt are a wash.

Actually, its everyone that understands economics thats laughing. You believe that lending cost can decrease as much as inflation increases?

Sure, you are borrowing $10B @ 3% due to excessive money printing....yet your material cost is going up 7% per year. Do the math, Bernanke.

Perhaps if interest rates go negative eh? Maybe if they pay you 4% a year to take the money?

Big building projects are FINANCED, that means borrowed money. So the exact opposite of what you're saying is true. It's deflation that hurts the business paying back the loan for the large projects. Inflation helps the borrowing business. As someone already pointed out, inflation/deflation arguments based on a debt are a wash.

Actually, its everyone that understands economics thats laughing. You believe that lending cost can decrease as much as inflation increases?

Sure, you are borrowing $10B @ 3% due to excessive money printing....yet your material cost is going up 7% per year. Do the math, Bernanke.

Perhaps if interest rates go negative eh? Maybe if they pay you 4% a year to take the money?

Totally irrelevant to backing up your statement that deflation lowers the cost of building projects.

Pro tip: Assuming magical inflation that affects all areas of the economy equally and at the same time (which simple minds like you always do), if your material costs are going up 7% per year, then the present value of the outstanding debt that you used to purchase that material is decreasing 7% per year, so it's a wash.

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Totally irrelevant to backing up your statement that deflation lowers the cost of building projects.

Pro tip: Assuming magical inflation that affects all areas of the economy equally and at the same time (which simple minds like you always do), if your material costs are going up 7% per year, then the present value of the outstanding debt that you used to purchase that material is decreasing 7% per year, so it's a wash.

No one is assuming that its spread evenly through the economy, moreover it is generally energy (ie. oil) and labor that see the first big influxes in price in response to inflation...Too bad large scale projects are so heavily dependent on these things....

If your material costs are going up 7% per year, then the present value of the outstanding debt that you used to purchase that material is decreasing 7% per year, so it's a wash.

Because of the increasing cost of developing the project, your first round of financing is no longer enough....so while the present value of that initial funding is discounted via inflation, you now need more funding to complete the next phase. There is no free lunch here. Moreover, each round of funding delays the project again and again do to the stop-start-stop impact on project management.

As I said, the Big Dig was supposed to be $2B and 5 years of work....in the end it was $22B and 14 years. Not only did it cost an extra $20B, but the opportunity cost from a missing decade is non-trivial.

The discussion of savers is also flawed. Deflation leads to hording money. Savers save by defintion, they don't spend their savings at a later date. All that money being saved (horded) is money not being circulated in the economy.

I think its unreasonable to presume that the bulk of savers die before they hit retirement, when they would start to pull from their savings. Of those who do croak, it seems even less likely that their heirs will simply sit on the cash until they die.

But even if all that money did remain unspent, it would still circulate thanks to the banks making loans.

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Because of the increasing cost of developing the project, your first round of financing is no longer enough....so while the present value of that initial funding is discounted via inflation, you now need more funding to complete the next phase.

Which will continue to discount at the same 7%.

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Yes, but aggregate increases of both debt-level and term does have effects. Mainly because banks aren't compelled to keep loaning ad infinitum.

Each time you are forced to scramble again for financing increases the odds that someone will balk, leading the whole project into disaster - or at the very least resulting in such a reduction of features (instead of building 20 miles of tunnels, you build 5) which causes everyone to view the project as a failure regardless.

Yes, but aggregate increases of both debt-level and term does have effects. Mainly because banks aren't compelled to keep loaning ad infinitum.

Each time you are forced to scramble again for financing increases the odds that someone will balk, leading the whole project into disaster - or at the very least resulting in such a reduction of features (instead of building 20 miles of tunnels, you build 5) which causes everyone to view the project as a failure regardless.

That's making the gross assumption that the project will run overbudget enough to actually need more financing (never mind doing this over and over). This requires the gross assumption that the project will take long enough and purchases will be drawn out enough for inflation effects to even matter. Which means you first have to make the gross assumption that there's 7% inflation of building materials costs to begin with. All of this additionally relies on the assumption that these (assumed, again) increased costs will outpace the declining value of the debt.

That's an awful lot of ASSuming. Are you sure that's actually a realistic scenario?

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Consider that in the first case, this is entirely normal and healthy! If the money supply is held constant, yet the productive capacity of the economy increases, there will be the same number of dollars chasing more goods. Inflation is the exact opposite of this, whereby same dollars are chasing fewer goods (or more dollars chasing same/less goods). Clearly deflation in this sense is beneficial for consumers. We see this taking place in the electronics industry which is largely free from government regulation and subsidies. When competition is fierce, the productive capacity of industry over-rides the inflationary aspects of our fractional reserve economy and we see prices come down as more and more electronic goods are produced more efficiently.

Debatable. IIRC the problems caused by this are partly why no countries are on the gold standard anymore. More unpleasantly, there's a really nasty catch in the "productive capacity of the economy increases" part, which I'll come to in a bit.

So let us look at Krugman’s second argument that deflation makes debtors worse off. What is left unsaid in this assumption is that debt is a good thing, while saving is a bad thing. Does this make any logical sense to anyone? Consider that if money is undergoing deflation, SAVERS benefit. Shouldn’t the savers naturally benefit more than someone who is putting themselves into debt? Savers are forgoing pleasure in the moment for the expectation of even greater pleasure in the future. This means resources that could be consumed immediately for minimal productive gains are being put aside into bigger projects that could yield even greater gains in the future. Savings is what builds strong economic foundations. If the US wasn’t so wildly in debt at the moment we would be in a better economic position with larger prospects for growth!

You seem to have got this exactly backwards. Remember that money itself isn't intrinsicly worth anything, it's just a way of allocating resources. So someone that stuffs $1 million under the mattress for future use actually benefits the ecomomy far less than someone that goes $1 million into debt in order to start up a new business. Now, what you were saying would be true if savings worked the same way in a deflationary economy as in an inflationary one with the money saved being loaned out through fractional reserve banking, but they won't - that's why savers can benefit even though it harms debtors.

But also let us consider the impacts of deflation on interest rates. People who lend and borrow money will know that money will be worth more in the future if the money supply remains constant (like Bitcoins) yet the productive capacity of the economy continues to increase. This leads to falling interest rates. Interest rates will naturally come down in a deflationary environment because savings will increase, thereby making more money available to banks to lend.

It may decrease interest rates in nominal terms, but in real terms - which is what matters to debtors - they will increase. If the real-world value of your debts increases due to deflation, that's effectively interest from your point of view, especially since your income will also be affected by deflation.

Your employer gathers up all the employees for a conference and tells you that because the economy is so productive and that the value of money is going up so much, that he is going to have to furlough the workforce to deal with the appreciating currency.

From your perspective, you are getting more time off while your income remains exactly the same in terms of purchasing power. Who doesn’t want that? Further, consider that if you don’t get a raise every year, YOU STILL GET A RAISE! Employers don’t necessarily have to cut wages; they can cut hours or simply not give raises yet people would still be better off than they were the year before.

But let’s say the economy is so productive that money gains so much value that employers are simply forced to cut wages – if this was the case, would anyone seriously give a damn? We would be living in a nirvana society that had absolutely ridiculous amounts of abundance. Women could stay home to take care of the kids, one man could provide all the income necessary to take care of his family and still retire, kids wouldn’t have to work three jobs to put themselves through school, etc… etc… etc…

Less people would need to work in such an economy (like they did in the 50s and 60s) which would relieve the need of employers to cut wages.

OK, this is where things get nasty. You talk about productivity gains, but so far they've mostly happened through decreases in the amount of labour required to manufacture items; the raw materials and capital costs have remained substantial and often even increased. This means that wages have generally decreased far faster than the costs of items have - this is a problem even without deflation. So an increasing amount of the cost of goods and services is going to a handful of very wealthy individuals that control the resources required to produce them. While we might end up with ridiculous amounts of abundance, the vast majority of the population isn't going to see it. What's more, the gains don't happen evenly: the cost of producing shiny technological items has decreased massively, but the cost of essentials like food and homes hasn't.

The other catch is that not all sectors of the economy benefit equally from this increase in productivity: in particular, for the most part service sector jobs haven't changed very much at all.

How would cutting hours work? Assuming the business is being run with reasonable efficiency, cutting hours worked will decrease the amount of product produced, decreasing income, and causing the business to shrink.

I don't think cutting hours would work. But it's a ridiculous argument anyway. The reason people resist having their wages cut is because the buying power of their money is not increasing. People in an deflationary society would fear inflation because they'd say employers wouldn't be willing to raise wages because in their society they cut them.

Krugman is essentially saying that employees are irrational and won't accept a decrease in wages even if their purchasing power still increases. If that's so, it's only because an inflationary economy has made them that way.

We expect wages to go naturally go up over time and resist reductions in our wages because that's what has to happen in our society for our purchasing power to even stay the same.

I am an employee of Ripple. Follow me on Twitter @JoelKatz1Joe1Katzci1rFcsr9HH7SLuHVnDy2aihZ BM-NBM3FRExVJSJJamV9ccgyWvQfratUHgN

You seem to have got this exactly backwards. Remember that money itself isn't intrinsicly worth anything, it's just a way of allocating resources. So someone that stuffs $1 million under the mattress for future use actually benefits the ecomomy far less than someone that goes $1 million into debt in order to start up a new business.

The problem with imposing such value judgements is that you inevitably wind up supporting the Broken Window fallacy. Moreover, its probably easily proved false without resorting to that. Simply put, that millionaire got that money in his mattress from offering some type of product / service that was *successful*. Obviously the market wanted / needed his service....whereas your potential entrepreneur who goes into debt, its pure speculation as to whether he will offer the market anything that it wants / needs.

So to say its "better" for the economy to have someone borrow $1M to build the biggest ball of string vs to have someone who successfully is running an ongoing business is just plain wrong.

OK, this is where things get nasty. You talk about productivity gains, but so far they've mostly happened through decreases in the amount of labour required to manufacture items; the raw materials and capital costs have remained substantial and often even increased. This means that wages have generally decreased far faster than the costs of items have - this is a problem even without deflation. So an increasing amount of the cost of goods and services is going to a handful of very wealthy individuals that control the resources required to produce them. While we might end up with ridiculous amounts of abundance, the vast majority of the population isn't going to see it. What's more, the gains don't happen evenly: the cost of producing shiny technological items has decreased massively, but the cost of essentials like food and homes hasn't.

The other catch is that not all sectors of the economy benefit equally from this increase in productivity: in particular, for the most part service sector jobs haven't changed very much at all.

I would posit that deflationary environments favor more wealth decentralization. Consider two points:

1. The person that spends $1M to buy a widget factory that is producing widgets he can sell for $100 each. In 10 years, the deflationary pressures push down the price of his widget to $10 each.....Now he is ready to sell his factory and lets assume all things being equal he can only fetch $100K for it now. Suddenly its within the grasp of someone how had saved $100K a decade earlier, but was "too small of a fish" back then to compete -- now that person has a chance to buy this resource. Savers are rewarded.

2. Alternatively, someone spends $1M to buy a widget factors that is producing widgets for $100. Thanks to inflation, in 10 years the widgets are selling for $1000 each. He is ready to sell now and prices the factory at $10M. Without considering considering all the debt-finance scenarios, his potential buyers are now from an even more rarified wealth stratum. Namely, those that were a level "above" the factory owner a decade earlier.

And if you look at the real world today, you see consolidation happens exactly like scenario #2. A business that is sold for $10M this decade is sold for $100M the next, and a $1B the next. Eventually ownership moves from local investors, to regional investment fund, to finally one of the major investment banks (JPM, Goldman, etc) that are directly connected to the money printing machine.

OP - I was all like TL;DR but then your horrible logic caught my attention, so now it's refuting time. I use strikeout to get rid of filth, garbage, and other meaningless fluff in your original article that doesn't add substance to your original claim of a counter-argument. My comments will be in italics, and I may emphasize my comments with bold in instances where your article is especially badly written (logic not relating at all)

You purport to refute this statement:

Quote

There are actually three different reasons to worry about deflation, two on the demand side and one on the supply side.

So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow…even a zero rate may not be low enough to achieve full employment.

A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts.

Finally, in a deflationary economy, wages as well as prices often have to fall – and it’s a fact of life that it’s very hard to cut nominal wages — there’s downward nominal wage rigidity.

Those arguments against deflation are typical Keynesian dogma. In fact I actually wrote out the exact same three arguments before I even read Krugman’s article, but I figured it would be better if I listed them off right from the horse’s mouth.

So let’s address the first argument that people become less willing to spend, and particularly less willing to borrow, and this somehow leads to unemployment. There will ALWAYS be some unemployment if the economy is not in equilibrium (which it never is, since human desires change over time). As people shift their desires from wanting notebook computers to iPads, some unemployment will result from this. Consider that if the demand for notebooks drops while the demand for iPads increases, notebook producers will end up having to lay people off or go out of business while iPad producers will be hiring more people. The people in transition are going to be unemployed while they look for new work.blah blah blah blah, shifting consumer desires occur under both inflationary and deflationary economies. You don't explain what this has to do with the fact that deflation does not equal reduced spending. At all.

But setting that point aside, we have to look at why money undergoes deflation in the first place! It is not surprising that Krugman doesn’t mention the reasons why deflation occurs in a currency. I'm feeling lonely.. where's the refutement to "So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow…even a zero rate may not be low enough to achieve full employment." ?[/i] There are basically only two reasons (on a macro scale) why a currency would undergo deflation:

1. The economy is producing more new goods and services at a rate that is above the growth rate of the money supply…. or

2. In a fractional reserve system, debt is being wiped out through widespread bankruptcies.

Consider that in the first case, this is entirely normal and healthy! No, it's actually not, but you don't live on planet Earth, so that's okay If the money supply is held constant, yet the productive capacity of the economy increases, there will be the same number of dollars chasing more goods. Inflation is the exact opposite of this, whereby same dollars are chasing fewer goods (or more dollars chasing same/less goods). Clearly deflation in this sense is beneficial for consumers. AHA!! what you're saying is people are wrong about deflation because deflation is good. I know a lot of four year olds that make this argument very convincingly... Pleease give me more chocolate because it's good for me.[/b] We see this taking place in the electronics industry which is largely free from government regulation and subsidies. When competition is fierce, the productive capacity of industry over-rides the inflationary aspects of our fractional reserve economy and we see prices come down as more and more electronic goods are produced more efficiently. LOL the electronics industry (at least on planet Earth) has operated in an inflationary environment. Whoops.[/b]

Imagine if the electronics industry operated like the government subsidized and regulated healthcare industry. Anyone notice how the topic of the article has shifted from talking about deflation to talking about regulation? Also, while the author is waaaay off topic, as a side note, the electronics industry is HEAVILY regulated by the IEEE & FCC, so even this straw man is horribly wrong[/i] You would buy all the electronics you could now, because in the future, they would be so expensive you might not be able to afford them! So yeah, in this sense, inflation encourages spending. But clearly this is UNHEALTHY spending caused by people fearing the loss of their purchasing power. LOL did you just state that inflation encourages spending? What does that infer about the opposite of inflation, e.g. deflation? Please go on and describe why A=B, but ~A =/= ~B LOL[/i]

Inflation creates a fear based economy that motivates people to spend above their means because the future value of their purchasing power is constantly decreasing. I don't know of anyone who goes about living this way. Most people that I know are competent enough to diversify their assets, so this isn't an issue, plus real inflation is roughly 0-2.5% atm... It would be foolish to try and save money for future expenditures in an inflationary economy, which obviously destroys savings. People who save for their retirement by putting money in a bank would be fools in an inflationary environment. Assuming zero interest. I get paid a lot of interest for my cash, and I hold a lot of it

In fact if the inflation gets bad enough and interest rates are artificially low, people would be motivated to take out excessive loans and credit card debt to try and get as many things as they could now! Boy that sure sounds like a problem we are all familiar with doesn’t it? Actually, this is only a problem if there (ironically) aren't enough regulations on the financial industry to prevent fraudulent/excessive/easy loans, and the creation of a deregulated OTC derivatives market (CDO, CDS, MBS, Call/Put)... but I'll agree with you for the sake of making this article complete garbage. Basically, you state that moderate inflation = moderate excess spending, and REALLY high inflation = REALLY excess spending. Using inductive reasoning, let's say A is inflation and B is spending: if A=B and 2A=2B, therefore 0A=0B. A bit of hyperbole, but you get my point - you are indirectly proving the very fact you are trying to dispute!

Krugman’s argument that people would be less willing to spend and borrow, and this would lead to unemployment, is as ridiculous as saying that because computers keep getting better and cheaper into the future, people would be less willing to spend money on a computer today because they could simply wait and buy an even better/cheaper computer in the future. This is partially false - a lot of computer buyers delay purchases to skip a gap in Windows releases, or to wait for the next Intel processor generation... etc. Also, how does this point relate to deflation at all?[/b] That is obviously not how people think. People have needs and desires that have to be met, and they will purchase things as soon as their desire for the product is larger than their desire for future earnings on savings. That, by the way, is how a healthy economy should operate. Notice there is no fear involved. Electronics companies are not going out of business because their products are becoming more abundant and cheaper.

So let us look at Krugman’s second argument that deflation makes debtors worse off. You did a great job supporting Krugman's first argument by inferring multiple times that inflation increases spending while deflation decreases spending. LOL! Continue 'refuting'... What is left unsaid in this assumption is that debt is a good thing, while saving is a bad thing. Does this make any logical sense to anyone? Consider that if money is undergoing deflation, SAVERS benefit. Shouldn’t the savers naturally benefit more than someone who is putting themselves into debt? Savers are forgoing pleasure in the moment for the expectation of even greater pleasure in the future. This means resources that could be consumed immediately for minimal productive gains are being put aside into bigger projects that could yield even greater gains in the future. Savings is what builds strong economic foundations. If the US wasn’t so wildly in debt at the moment we would be in a better economic position with larger prospects for growth! Where in this paragraph do you talk about debts becoming easier to pay off in a deflationary economy? I think saving's a good thing, but what does Saving-Is-Good have to do with addressing Krugman's point?[/i]

But also let us consider the impacts of deflation on interest rates. People who lend and borrow money will know that money will be worth more in the future if the money supply remains constant (like Bitcoins) yet the productive capacity of the economy continues to increase. This leads to falling interest rates. Interest rates will naturally come down in a deflationary environment because savings will increase, thereby making more money available to banks to lend. But you just said in the previous paragraph that less lending is good![/i] When banks have a lot of people saving money with them, they will lower rates naturally. This is in contrast to our present situation where rates are low strictly because the Fed is artificially depressing them by paying banks NOT to lend and by buying up government bonds. oic, a Fed hater.. Libertarians hate feds like feminists hate men, I guess[/i]

Distortion of interest rates by the Fed also has other deleterious effects on the structure of production that I will not get into here, but according to Austrian Business Cycle Theory, inflation and its distortion of interest rates is the primary driver of business cycles. Learn more about it by watching this video by Professor Roger Garrison.

Which situation sounds healthier to you? Low interest rates because a lot of people are saving money or low interest rates because the Fed is artificially depressing them with tax payer money?

So let us address Krugman’s final argument I'm going to give you 50% odds at this point that you'll either accidentally support Krugman or just go off on a wild fed-hating-meaningless tangent here[/i] that wages face downward rigidity which makes it more difficult for employers to adjust to the money that is gaining in value.

Consider if you were in this situation:

Your employer gathers up all the employees for a conference and tells you that because the economy is so productiveAw, really? Give me ONE historical instance where GDP increased rapidly during a period of deflation. One. and that the value of money is going up so much, that he is going to have to furlough the workforce to deal with the appreciating currency. But doesn't furlough decrease productivity? So what you're saying is, deflation decreases economic activity?[/i]

From your perspective, you are getting more time off while your income remains exactly the same in terms of purchasing power. Who doesn’t want that? Further, consider that if you don’t get a raise every year, YOU STILL GET A RAISE! Employers don’t necessarily have to cut wages; they can cut hours or simply not give raises yet people would still be better off than they were the year before.

But let’s say the economy is so productive that money gains so much value that employers are simply forced to cut wages – if this was the case, would anyone seriously give a damn? Yeah, most people have loans which can't be easily modified and have to be paid back over 5, 10, or 30 years. If your income decreases from $3000 a month to $2500 a month due to a pay cut, and you have been paying a $1000/mo mortgage, $250/mo. car payment, plus student loans...[/i] We would be living in a nirvana society that had absolutely ridiculous amounts of abundance. Only if there was zero debt, since I just proved debt is bad in deflation...[/i] Women could stay home to take care of the kids, one man could provide all the income necessary to take care of his family and still retire, kids wouldn’t have to work three jobs to put themselves through school, etc… etc… etc… ALL OF THOSE THINGS HAPPENED AFTER THE U.S. LEVERAGED AT 140%+GDP AROUND WORLD WAR II, THE EXACT OPPOSITE OF YOUR ARGUMENT[/i]

Less people would need to work in such an economy (like they did in the 50s and 60s) which would relieve the need of employers to cut wages. LOLOLOLOL[/i]

Oh yes, one more thing. I suppose I should address the second cause of deflation other than increasing productivity while the money supply remains constant – and that is a deflationary default spiral that results from the unwinding of a Ponzi scheme. This is the real reason why Keynesian economists fear monger about deflation. Since in our crazy society, money IS debt, if debtors get themselves into a position where they are so over-leveraged that they are forced into bankruptcy, it can cause a cascading series of defaults that wipe out the banking industry (along with the government and its welfare/warfare state). As debt gets wiped out, the money supply decreases which leads to deflation. This only happens when you libertarian nutjobs get your way and have a deregulated financial sector.[/i]

Keynesian economists have to continually fear monger about deflation because even a tiny amount of it could wipe out our Ponzi debt based economy, and thereby wipe out their fat government aid fueled paychecks. To learn more about the scam that is our debt based economy, check out The Case Against The Fed. It offers a clear picture of how the modern banking system operates and why it was created. If you are looking for something slightly more entertaining, yet still informative, check out The American Dream. It is gives a great overview of what fractional reserve banking is and why it is nothing more than a Ponzi scheme.get your garbage links outta here![/i]

Keynesian economists like Krugman don’t have your best interests in mind when they argue against deflation. They are far more concerned about keeping the welfare/warfare state alive and well, along with their own paychecks. If only Krugman wrote articles as badly as you did.[/i][/quote]